How Banks Value Commercial Property
This is a bit of a misnomer because in truth its Valuers that perform this role in most cases not banks. This is not meant to be a lesson in valuation by the way, apparently I need a degree to perform that job, so for now its just information based on my experience in the business that you are getting.
Valuers use a number of methods to determine a range of values for a commercial property and then usually select the most appropriate method or a price within the computed range.
In many cases valuers will use the above methods together to produce a result.
So, they know that the rate people are willing to pay for a property produces a return of 8.5%. They have also found a number of properties in the area you wish to buy in with rents of $100,000 that have been sold at between $980,000 and $1.3M. These two pieces of information can then be used to justify the valuation of say $1.2M
The problems usually occur between borrowers and banks when someone owns a commercial property themselves and wants to borrow more money when the market is in a downturn. In this situation, you may own a property and have no intention of selling. You might have a great tenant and a great business so your risk profile is low. Unfortunately because the properties around you are being sold for cheap prices as people default on their loans, your own property value comes down. This not only affects your current borrowing capacity but may affect your banking facilities.
Imagine if your overdraft or term loan is expiring and you want to extend it, only to find that the collateral you have with the bank just dropped in value by 30%? It happens, regularly!!!